U.S. stock market fulfilling historical trends in September

KateGibson

NEW YORK (MarketWatch) -- Two days into September, the month is living up to its reputation as the year's most treacherous for equities. But one 20-year market veteran says there is a logical explanation, all having to do with fund managers clearing tax liabilities for their customers.

"There is a reason why September has such a negative history. "When you're a portfolio manager and you have gains for the year, do you pass that tax liability along to your customers or sell something you have a loss in," said Marc Pado, U.S. market strategist at Cantor Fitzgerald.

'Profit-taking in groups that have done well suggests that this is nothing more than a seasonal pullback, which can be considered a healthy setup for a fourth-quarter run.'
Mark Pado, Cantor Fitzgerald

"It's not a call on the economy, or the market, or valuations or anything else. It's a tax issue," said Pado of September's dismal track record for equities, as evidenced by Tuesday's sharp decline in the midst of positive economic data.

And, given most mutual funds have a September or October fiscal year, the current month historically is the month to "sell stocks you have losses in," said Pado.

Others agreed that the month's first session had little to do with economic reports.

"The day had less to do with negative economic news and [was] more about a self-fulfilling prophecy," said Robert Pavlik, chief market strategist, Banyan Partners LLC.

Pavlik disputes the notion that a correction's overdue in the wake of the roughly 50% rally off March lows, saying improved economic conditions and earnings guidance, combined with low inventory levels, make additional gains in the stock market "quite likely."

Long-term investors should use market pullbacks to reallocate assets into early cyclical sectors -- such as financials, consumer discretionary, technology, materials and industrials-- while trimming exposure to defensive sectors, Pavlik advises.

On Wednesday, financials again fronted the losses as U.S. stocks extended a losing streak into a fourth session.

Pado said the fact that financial shares led Tuesday's large market drop illustrates his point about the market.

His theory involves selling stocks that have recently performed the best, a display of what he calls "clear profit-taking rather than a fundamental shift" in market sentiment.

"We need to see an occasional profit-taking round to digest the moves we've had," he said. "Profit-taking in groups that have done well suggests that this is nothing more than a seasonal pullback, which can be considered a healthy setup for a fourth-quarter run."

In an email, one reader of MarketWatch, offered a differing view, wondering whether the "monetary demands of the academic year [might] cause some people to cash in a portion of their equities in September."

Taxes and the big guys

As of a few years ago, 75% of total equities were held by mutual funds, with that percentage since dented some by hedge funds. "It's the big guys, the Fidelitys and the Putnams. Ordinary people don't normally put money into hedge funds," said Pado.

"If you purchased in 2007 or 2008, you are likely to have big losses. If you take those losses, then you don't have to buy capital gains. That's why you have downside pressure for September. It's also the reason the market tends to bottom in October," he said.

"If you think from the mind of a portfolio manager, and you sell for a tax loss, you can't buy the stock back for 31 days. So sell in September, then toward the end of October you buy your positions back. In good years, you don't have a lot of losses to take, so you don't have that much of a negative influence," Pado said.

"Coming off a bad year, you likely have stocks that have losses to offset any gains you caught at the bottom. That's a big plus," he said.

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